Airport Privatization: How It Works In Russia

Russia has already tried all the models for attracting private capital to the airport business, but the main mechanism was privatization through open competitions. What serves as the signal to invest in one Russian airport or another?

A box made of glass and concrete, a runway built with state funds, and a sufficient number of potential passengers within a radius of 100 kilometers. These would seem to be the main ingredients for a successful start to an airport business. Such investments are comparable with commercial real estate, but rental rates in the airport business are higher than in the most expensive business centers or shopping centers. Judging by the increased attention to airports from investors both in Russia and in Ukraine, such a concept seems attractive to many. So far, we do not have enough positive experience in this area.

There have been attempts to sell or lease out a number of regional companies. Suffice to recall the story of the return of the Ternopil or Kherson airport to communal ownership, the unsuccessful attempts to award a concession contract for operation of the Luhansk airport to a local metallurgist, or the still-unresolved problems involving monopoly and ownership of the runway in Dnipropetrovsk. A Kharkiv airport and Kyiv’s Zhuliany airport could serve as a good example, but such cases are still rare. Perhaps, this is because a successful format for cooperation between the state and private investors has still not been found.

In Russia, however, they have already managed to create entire airport holdings, although no more than 7% of the airports there are so far in private ownership. However, experts believe that the number of privately owned airports will increase. "The Russian authorities have embarked on privatization of the airport assets remaining in their ownership, which confirms the theory that a private owner is more effective than the state," said Dmitry Baranov, a leading expert with the Finam Management company." It is the same in Ukraine, where this area is still almost untouched.

Where do you get the passengers? Privatization, concession, and long-term lease: all these mechanisms for attracting investments to airports have been tried in Russia. In the end, the main mechanism chosen was privatization through open competitions. This was specifically how the present-day key investors in this area accumulated their assets. Three of the most notable players are Viktor Vekselberg’s Renova group (which owns the Yekaterinburg, Samara, Nizhny Novgorod, and Rostov-on-Don airports, which have a combined passenger traffic of 7.3 million), the Roman Trotsenko family’s Novaport (the Novosibirsk, Chelyabinsk, Volgograd, Tomsk, Barnaul, and Chita airports, which have a combined passenger traffic of 5.4 million), and Oleg Deripaska’s Basic Element (the Krasnodar, Sochi, Gelendzhik, Anapya, and Eysk airports, which have a combined passenger traffic of 5.4 million). All of them built their holdings based solely on regional airports. Yevgeny Chudnovsky, who is the general director of the Airports of the Regions Company (an airport holding company belonging to the Renova group), said that the decision to invest in one airport or another is primarily based on passenger traffic.

"We are interested in all the major airports that have passenger traffic of at least 1 million per year or airports that can quickly reach this figure. However, the number of such airports is very limited," he said in an interview with the Russian newspaper Kommersant. It is clear that it is not as limited in Russia as it is in Ukraine: no more than three or four airports have passenger traffic that is at such a level or close to it. Our main difference from our neighbors is that Russia’s domestic traffic has traditionally been significantly higher than its international traffic. Here, on the other hand, the Kyiv-based Boryspil airport and international flights account for more than 80% of the total traffic.

Investors are interested in all the major airports with passenger traffic of at least 1 million per year, but the number of such airports is very limited

Of course, it is important to consider traffic forecasts because the air mobility of the population is constantly increasing. According to the European Aviation Bureau, the aviation mobility coefficients in 2008 were 0.13 in Ukraine (i.e., 13 out of 100 people made at least one flight per year) and 0.31 in Russia. By comparison, the air mobility coefficients were 4.46 in Norway, 2.23 in Spain, and 1.16 in Germany. By 2011, the coefficient for Russia had risen to 0.45. In addition, it is assumed that the aviation activity of the population is directly dependent on GDP growth: a 1% GDP growth results in a 2% increase in aviation traffic. Based on this approach, a real aviation boom is taking place in both Russia and Ukraine. For example, Ukraine’s GDP grew by 5.2% last year while the increase of passenger traffic in Ukraine over the past year was 21.7%. In Russia, the situation is similar: its GDP grew by 4.3% last year while its air traffic increased by 12.7%.

In tandem with the state A compulsory stimulant of investor interest in airport infrastructure is infusion of cash into the industry by the state. According to international practice and international law, private ownership rights can only extend to ground-based infrastructure associated with commercial functions. Runways are of strategic importance and should belong to the state. The state is also expected to invest in construction and proper maintenance of runways, and such investments are often higher than investments in construction of airport terminals. It is clear that without a good runway, successful operation of an airport is out of the question. Therefore, an investment boom is being observed specifically where there is an infusion of state budget funds.

In both Ukraine and Russia, these investments were associated with events of international scale. In Ukraine, three airports were completely reconstructed with state funds ahead of the 2012 European football championship. In Russia, the impetus for the investment boom was the anticipation of events such as the 2014 Winter Olympics in Sochi, the 2018 FIFA World Cup, and the Expo 2020 world exhibition in Yekaterinburg. It is specifically for the Olympics that Oleg Deripaska is building his airport holding company, the airports of which are concentrated in the south. With the aim of recouping his investment during the 2018 FIFA World Cup, the Renova group acquired the Yekaterinburg, Samara, Nizhny Novgorod, and Rostov-on-Don airports (these are four of the 11 cities that will host matches during the World Cup).

Earlier this year, former Russian minister of transport Igor Levitin said that the government was planning to invest RUR 195 billion (more than USD 6 billion) in development of airport infrastructure and that it expected to attract the same amount from private investors. Approximately the same amount (RUR 192.4 billion) had already been spent from the Russian state budget on airports in the period since 2000. In Ukraine, about USD 1.3 billion from the state budget was spent on airports during the preparation for the 2012 European football championship, although there was no success in attracting private investors.

The joy of privatization The mechanism for privatization of airports in Russia has proven to be quite profitable for the state. The sale of airports occurred gradually, and the creation of several holding companies resulted in competition for the new airports. Therefore, there were several bidders each time the next promising airport was put on sale, and this allowed its price to go up.

For example, when the government auctioned a controlling stake in Tolmachevo (the Novosibirsk airport that was the third largest in the country in 2011with a passenger traffic of 2.8 million), Roman Trotsenko’s company, Viktor Vekselberg’s Renova, and Mikhail Abyzov’s E4 company all bid for it. Because of this, the total price of the controlling stake in the airport increased 2.5-fold from the starting price to RUR to 2.8 billion (USD 90 million) during bidding. For the Sochi airport (the third largest in Russia in terms of revenue with USD 145.2 million in 2011), which was eventually acquired by Deripaska, bids were received from Renova and the shareholders of the Vnukovo airport, as a result of which the price of the airport soared from RUR 3.5 billion to RUR 5.5 billion (USD 178 million) after the 40th round of bidding.

Of course, not every privatization took place flawlessly. The privatization of Russia's largest airport, Domodedovo (with a passenger traffic of 25.7 million and a revenue of USD 1.2 billion in 2011), which was privatized through the long-term lease mechanism in 1997, is still remembered. Russia’s Federal Property Management Agency began attacking the comoany in 2005 and challenged its privatization through the courts, although the agency failed in this bid. The ownership structure of the airport has changed many times since its privatization, but its ultimate beneficiaries have never been made public. According to the Vedomosti publication, the controlling shareholders of the company are members of its top management - Dmitry Kamenschik and Valery Kogan. Possible sale of this airport has been discussed in the Russian mass media throughout this year, and many companies have expressed interest in it, including Ziyavudin Magomedov’s Summa group, Renova, and Basic Element.

The negotiations have gone quiet for now. Ostensibly, the plans of the airport’s owners remained unclear until the end. Possibly, these difficulties are arising also because the authorities’ issues against the owners of the airport have not been resolved. Despite the fact that the airport has repeatedly received high marks from international experts, the fact that it has even been named as the best airport in Eastern Europe, and the fact that its level of development over the years can be seen with the naked eye, its old problems continue to follow it around. These include the terrorist attack that took place a few years ago and the problems caused by weather conditions at the end of 2010, when the airport was without electricity for a few days, after which a criminal case was even filed on suspicion of failure to provide security at a transport infrastructure.

The approach to attracting investment to the Pulkovo airport in St. Petersburg is radically different. So far, this is the only airport infrastructure in Russia where the concession mechanism has been used. In 2010, a 30-year concession on the airport was granted to a consortium of international investors that includes VTB Capital, Fraport AG (the global airport operator that controls, for example, the airport in Frankfurt), and the Greek investment group Copelouzos. Investment in construction of a new international passenger terminal should amount to USD 1.3 billion and the concession fee payable to the city equals 11.5% of revenue. The airport’s passenger traffic is expected to increase from 10 million to 25 million by 2025.

Whither progress Experts have difficulty determining which of the investment mechanisms is the most effective. "We do not have so many examples of long-term lease and concession agreements. Lease is the story with Domodedovo airport. Concession is the story for the Pulkovo airport. There are quite many privatized airports, but it cannot be said clearly that one method is good and that the other is bad. Domodedovo is a very interesting project. The development of infrastructure there was in leaps and bounds. However, friction with the authorities has led to a slowdown of the pace of investment. At Pulkovo, the new terminal has not yet been built, so it is impossible to measure its effectiveness. But investment has been attracted,” said Oleg Panteleev, the head of the Aviaport analytical agency.

According to him, the example of Pulkovo can perhaps be called exemplary. "In my opinion, the Pulkovo model is the most progressive: the airport belongs to the city, the company managing it has brought in investment, it is building a terminal and other facilities, and it will return everything to the owner after a certain period. The interests of all the parties - the investor, the management company, and the owner - are well protected under this mechanism. However, this is the only such example among the major airports," said the expert.

Of course, an investor, even if it is coming to a readied infrastructure, needs to understand that an airport is not just a giant box made of glass and concrete. The equipment that needs to be purchased for servicing passengers and aircraft accounts for approximately 30-40% of the cost of construction of a terminal, according to estimates by experts. It is hardly possible to recoup the costs through airport charges because most of them are regulated by the state, Panteleev explained. The only fees that are not regulated are the fees for provision of ramps, cleaning of aircraft, and registration of passengers for flights (operator can set these fees themselves).

However, airline companies include these fees and the regulated fees in ticket prices, which have a bad effect on passenger traffic. Therefore, the accepted norm is to offset airport business costs with high rental rates for commercial space. That is why prices in airport shops and restaurants are so high. Owners of airports around the world are trying to reorient the structure of their incomes specifically toward non-aviation operations. It is the most profitable operation for airports because its costs are minimal and its revenues are high, as opposed to aviation operations. For some reason, passengers always find it more pleasant to leave USD 100 behind when buying gifts - even at overstated prices - than to overpay for air tickets. In the end, there is similarity with the property development business: facilities are located in a way that will force visitors to buy as much as possible. However, this is probably the only similarity.